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Fatca/CRS – Customer tax compliance for financial institutions

New laws governing the global Automatic Exchange of Information – currently being implemented as the OECD Common Reporting Standard (OECD CRS) – among major nations will place a greater compliance burden on financial institutions, many of which are already grappling with the complexities of the Foreign Account Tax Compliance Act (Fatca), the bilateral anti-tax evasion legislation imposed by the US.

Provision of robust data will lie at the heart of CRS requirements and, in this interview, Dr Wolfgang Göb, head of business development at software vendor Software Daten Service (SDS), explains how financial institutions can begin to tackle the reporting challenges they will face.

Risk: There is a misconception that the CRS regime is merely an extension of Fatca. In what ways is CRS fundamentally different from Fatca?

Wolfgang Göb: There are two or three points that we need to delve into. In one of them, the two regimes are pretty similar. In two others, they’re not. The one in which they are fundamentally different from one other is the underlying regulatory framework. Fatca is based on a US law about withholding taxes. If you read it carefully you see that a major part of this law is about withholding tax on specific payments, and then a part follows that is about how to avoid that withholding by reporting US citizens and their accounts to the Internal Revenue Service (IRS). That, effectively, makes it a withholding tax issue and a way you can avoid the withholding. Still, withholding of taxes may happen. In 99.9% of the cases, withholding does not need to take place but, in a few cases, it will. So, it has something to do with withholding a tax and uses a tax as one of the means to actually propose the law. That is fundamentally different from what we see with CRS. CRS doesn’t know about withholding. There is no withholding tax in it. It is just a regulation, an international agreement that finally will be mapped into local laws and regulations and work by the nature of the law. That’s where it is fundamentally different.

The second thing is, what is similar between the two things? It is what you need to do, how you identify non-domestic clients, and what is the data that is exchanged between governments? That’s pretty much similar. Going into the details of this and all of these XML-formatted strings that need to be exchanged, you see 90% of the attributes there are effectively the same. There are some minor tweaks, but that’s it. That’s the greatest similarity. What is different – if you go down into the procedures that are required – Fatca effectively is about caring for the US client base of a financial institution. That may be a very small number, it may be such a small number that you just consider kicking them out. Effectively, with CRS, we are talking, let’s say, in the UK and Europe. We are talking about reporting old and non-domestic account holders that a financial institution may have. That’s a significant proportion. This is not just a few clients, it may be 5%, 10% or even more of your client base, and this is something that you neither circumvent nor avoid. This is not something minor, it is a major thing and it requires a lot of more data to be captured and a lot more detailed procedures to be walked through in order to do the KYC [Know Your Customer] and the reporting properly.

Risk: The timescale for implementation of CRS is ambitious – January 1, 2016 for early adopters. What types of challenges will these early adopters face in order to meet this deadline?

Wolfgang Göb: Well, the first and foremost thing you mentioned is the very tight deadline. So, we talk about 2016 – that is not a long time away – for initially being able to identify clients. First reporting will be due a year later, in early 2017, backdated for the previous years. Now, implementing CRS is not only about implementing the procedures, the IT changes, and so on, it is also about getting additional client information. So, you’re going to need to contact clients; you’re going to need to ask questions; you’re going to need to wait for the things coming back and information coming back. So, I think this part and the pressing timeline is probably the most difficult thing about CRS implementation and the most pressing thing.

Risk: The cost to the banks and businesses of complying with these new legislations could be sizable. How can banks and businesses mitigate these costs?

Wolfgang Göb: To some extent, they probably cannot. So, there will be costs associated. It’s crystal clear. The question about mitigating costs is always connected to ‘what is there that I can automate?’ ‘Is there anything that I can automate, that I can industrialise and make as cheap and as reliable as possible?’

Now, if you run through the whole process of CRS or Fatca compliance, we have the issue of know your customer, of new customer onboarding, of screening, and of reporting. Know your customer, face-to-face conversation with the customer onboarding is something that cannot be automated. That is clear. So, there is a major cost block. Automatic screening of existing clients can be automated to some extent. It’s very difficult because you have to tap into different sources and different applications. That’s very costly. Once you have it right and implemented, it will work at low costs. The one thing that you can potentially automate is the reporting stage. You have the data ready in a raw format; you’re going to need to validate it a last time and then create the reports that are then sent to the competent authorities. That is the ‘motorway’ of CRS reporting. That’s the part where some real cost-savings can be done, where shared service centres can be set up, and the like.

Risk: The success of CRS will depend on the quality of the data provided. How can banks ensure the data they provide is as robust as possible? Do you think there are any further barriers – regarding data privacy issues, for example?

Wolfgang Göb: Data privacy is one of the biggest concerns in that area. Of course it is sensitive information. So why have Fatca and CRS been introduced? It is about chasing down tax evaders. So, anything that you do, anything that you file in that area is something that is risky because you somehow put your client in a risky position. They may or may not be aware about what you are filing there and this may put them in an awkward position – even more of an awkward position if anything goes wrong, if they are reported by mistake, if they are wrongly reported, and so on. There may be enormous damage to a client relationship.

So, what can you do in those terms? Number one of course is, always, to get your data right at the source. Put a validation principle on this – validations plus ability checks, and so on, and try to set up something that is doing plausibility checks, probably comparing values with what you have reported last year. Does it still fall in line with what we saw last year in terms of amounts of balances that are reported? Stuff like this can help. Finally, a good IT application environment will help. It doesn’t help if you have five or 10 applications open in front of you just to make Fatca or CRS right. As a client adviser, you’re going to need to have a single screen. You’re going to need to have a workflow that guides you step by step to ensure that the data capture at source works. If you get that one right, the reporting will comply automatically.

Risk: Why is Fatca so high on the agenda? Why do you think foreign financial institutions buy standard software products from Fatca?

Wolfgang Göb: Fatca is high on the agenda for several – let’s say, almost political – reasons. It has clearly popped up in the aftermath of the financial crisis starting in 2008. Fatca was enacted in 2010. The OECD jumped on the bandwagon to get similar data. So, number one, it is a political issue. It is about the financial industry getting things right and reporting properly, which has a very positive appeal to the public.

Number two is about getting tax evasion right and to tackle tax evasion. That’s a point that also has a certain political appeal. So, seeing it from pure public opinion, it is something that is pretty attractive to do and is something that should be done. Now, in turn, the financial industry feels enormous pressure to get that right. No one wants to have an issue with this. No one wants to have an issue with authorities like the IRS anymore. Swiss banks have experienced how deep the problems they run into can be, with coming close to tax evasion and tax fraud schemes. The UBS case is very prominent. So, the reputational damage that a financial institution can have is massive. So, that’s why Fatca is high on the agenda. Still Fatca is pretty much standardised around the globe. There are some things that may vary from country to country. We hope that CRS will be the same thing and, as soon as things become standardised on a global scale, it is an area where a standard product, standard software or standard solutions make sense for two reasons. Number one is cost, number two is reduced risk.

Risk: What was the reason for SDS offering standard software solutions?

Wolfgang Göb: We are a long-standing vendor in that market. Actually the company is now more than 40 years old. We always have been active in that area, producing standard packages that can have a bit of a tailoring, a bit of a parametrisation specific to clients. When Fatca came up, it was a natural extension to the software products that we provided for the qualified intermediary regime. The QI [Qualified Intermediary, aka Chapter 3 reporting] regime was put in place by the US more than a decade ago, and was a first attempt to crack down on tax evasion. It didn’t work as well as the Americans wanted it to do. That’s the reason why they came up with Fatca; to close all the loopholes that it showed. But we were active in that space. It was here and we had a good experience with that and, when Fatca came up, we said: ‘okay, that’s a natural extension of our portfolio, that’s something that makes sense to put into a standard product’. We deliberately focused on the reporting part of the issue after an analysis, that this would be where a standard product would really fit in, where a standard can have its place, where automation takes place and where we can successfully market a product to a multitude of clients.

Risk: What was your experience between implementation and best practices?

Wolfgang Göb: Fatca implementation is currently on its way. First reports are more or less out depending on the exact agreement that clients are working on, they will have either already prepared some reports, they will submit in a few months or a few weeks. We have seen certain benefits from starting comparatively early with the project. So, our first clients began this process more than a year ago with implementing the reporting part of Fatca. They started their whole Fatca project several years ago and this now gives them the opportunity to already use a futureproof standard solution for the initial year of reporting. Others are not so lucky. Many institutions are going to need to work on what they call a tactical solution for that year, which effectively means to get the reporting done in one or the other way and then implement for the next year a proper, more strategic solution. So, best practice is, potentially: to start early; try to find operational models where the reporting can be done in centralised service hubs, with everyone else delivering the data into this central hub; set up a group-wide service centre that will then process the data; and take responsibility for the filing.

Risk: So, what next?

Wolfgang Göb: That’s a good question. The natural thing that is next is OECD CRS. That will keep us busy until 2018 at least. 2017 will be the first year of reporting, and we will see a lot of things being fine-tuned in 2018. So, that already fills a timescale of – let’s say – three years. Where will this lead?

One question is, how complex will CRS be? How many countries will implement something that goes beyond this minimum standard that CRS actually sets and will implement something more complex? Will there be an appetite for significantly more and more detailed data? That’s something that I can easily envisage. That’s what can happen with CRS in the next wave. We can clearly see also the area of – let’s say – customer tax compliance. So, anything that a financial institution needs to do in order to have their clients tax-compliant… that’s on the rise, that’s clear. And this goes far beyond just a reporting stage. That’s about calculating taxes, withholding taxes for the client, reporting to the client about what has been withheld, filing reports to competent authorities, to national authorities, and do this for domestic tax reporting as well. Complex schemes may arise like capital gains tax and similar tax regimes and I think that’s the next thing that financial institutions will start to tackle or have to tackle in order to get a very clean track record in terms of tax compliance and that is also something that goes very deeply into the application landscape of a financial institution.

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